Chapter 1
The Role and
Environment
of Managerial
Finance
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Learning Goals
• What is finance?
• What do financial managers do?
• Relationships between finance &
economics/accounting
• What is the goal of financial decisions?
• The agency issue.
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What is Finance?
• Finance can be defined as the art and science of
managing ______________________________:
it is the process of how organizations and
individuals ___________________________
and ___________________________________.
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Major Areas & Opportunities in Finance:
Financial Services
• Financial Services is the area of finance
concerned with the design and delivery of
advice and financial products to individuals,
businesses, and government.
• Career opportunities include banking, personal
financial planning, investments, real estate, and
insurance.
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Major Areas & Opportunities in Finance:
Managerial Finance
• Managerial finance is concerned with the duties of the
financial manager in any organization.
• The financial manager actively manages the financial
affairs of any organization, whether private or public,
large or small, profit-seeking or not-for-profit.
• They are also more involved in developing corporate
strategy and improving the firm’s competitive position.
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Figure 1.1 Corporate Organization
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Table 1.3 Career Opportunities in
Managerial Finance
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The Managerial Finance Function
• The size and importance of the managerial finance
function depends on the size of the firm.
• In small companies, the finance function may be
performed by the company president or accounting
department.
• As the business expands, finance typically evolves into
a separate department linked to the president as was
previously described in Figure 1.1.
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The Managerial Finance Function:
Relationship to Economics
• Finance is actually an outgrowth of economics.
• In fact, finance is sometimes referred to as
financial economics.
• Financial managers must understand the
economic framework within which they operate
in order to react or anticipate to changes in
conditions.
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The Managerial Finance Function:
Relationship to Economics (cont.)
• The primary economic principal used by
financial managers is marginal cost-benefit
analysis which says that financial decisions
should be implemented only when
_____________________________________
_____________________________________.
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The Managerial Finance Function:
Relationship to Accounting
• The firm’s finance (treasurer) and accounting
(controller) functions are closely-related and
overlapping.
• In smaller firms, the financial manager generally
performs both functions.
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The Managerial Finance Function:
Relationship to Accounting (cont.)
• One major difference in perspective and
emphasis between finance and accounting is that
accountants generally use the accrual method
while in finance, the focus is on
____________________________________.
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The Managerial Finance Function:
Relationship to Accounting (cont.)
• Finance and accounting also differ with respect to
decision-making.
• While accounting is primarily concerned with the
presentation of financial data, the financial manager is
primarily concerned with analyzing and interpreting
this information for decision-making purposes.
• The financial manager uses this data as a vital tool for
making decisions about the financial aspects of the
firm.
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Goal of the Firm
• Goal of financial decisions: maximize
shareholder wealth by maximizing the
________________________________.
• The market price of a firm’s stock reflects:
– Expected ________________________
– ________________________ of the cash flows
– ________________________ of the cash flows
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The Role of Ethics: Ethics Defined
• Ethics is the standards of conduct or moral
judgment—have become an overriding issue in
both our society and the financial community
• Ethical violations attract widespread publicity
• Negative publicity often leads to negative
impacts on a firm
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The Agency Issue:
The Agency Problem
• Whenever a manager owns less than 100% of the firm’s
equity, a potential agency problem exists.
• In theory, managers would agree with shareholder
wealth maximization.
• However, managers are also concerned with their
personal wealth, job security, fringe benefits, and
lifestyle.
• This would cause managers to act in ways that do not
always benefit the firm shareholders.
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The Agency Issue:
Resolving the Problem
• Market Forces such as major shareholders and
the threat of a hostile takeover act to keep
managers in check.
• Agency Costs are the costs borne by
stockholders to maintain a corporate governance
structure that minimizes agency problems and
contributes to the maximization of shareholder
wealth.
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The Agency Issue:
Resolving the Problem (cont.)
• A stock option is an incentive allowing
managers to purchase stock at the market price
set at the time of the grant.
• Performance plans tie management
compensation to measures such as EPS growth;
performance shares and/or cash bonuses are
used as compensation under these plans.
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